Homebuilders Get Nailed By Rising Costs

Investor's Business Daily

As if U.S. homebuilders haven't had enough woes over the last few years, there's now this: rising costs of materials and labor that are squeezing already-tight margins.

Prices of essential building materials for home construction — such as lumber, gypsum and concrete — have been on a rapid rise as demand for these goods outpaces supply.

At the same time, for some builders, prices of homes aren't rising fast enough to cover the added expenses, leaving many of them with no choice but to swallow the costs.

According to data from the National Association of Home Builders, the price of gypsum — a key ingredient in drywall — is now at 94% of its peak price established during the housing boom of 2006, when builders could offset higher costs with higher home prices.

Lumber prices have rebounded to 93% of their peak, while concrete is at 99% of its peak.

The main reason prices are up is that producers and distributors of these materials don't have the capacity to meet rising demand for new homes. When supplies are short, prices rise.

"Producers reduced capacity during the homebuilding slump — they closed plants, laid off workers and sold capacity. It will take them a while to bring that back again," said NAHB Chief Economist David Crowe. "Suppliers haven't opened up capacity as fast as builders have responded to consumer demand.

The price of labor also has risen for many of the same reasons. Many carpenters, framers and other workers who were laid off during the housing slump moved on to other industries, leaving the homebuilding industry with a shortage of skilled labor.

"Housing production sunk so severely that workers had to find jobs somewhere else," Crowe said. "Some of them went to the energy sector, which is booming, so they probably won't come back.

Supply And DemandNormally when costs go up, businesses respond with higher prices. But that hasn't been an option for many builders who've had to compete against a large supply of existing homes sitting empty, even though the supply of existing homes for sale is coming down. The National Association of Realtors says existing-home listings fell to a 4.7-month supply in March from a 6.2-month supply a year earlier.

"While there has been some movement in house prices, it hasn't been enough to cover these increased costs," Crowe said. "Consumers are looking for bargains. Builders can't price beyond the appraisal value and must compete on market prices.

The result is that many builders must learn to get by with lower margins, says Alan Banks, owner of privately held Evans Coghill Homes in Charlotte, N.C. He knows from personal experience.

Banks' company, which specializes in building custom homes, just sold a 3,400-square-foot home in the Charlotte area. Historically, a house of that size would include about $17,500 in lumber costs. Due to higher prices, however, the company had to pay $22,500 for the lumber this time.

That doesn't mean Banks could raise the price of the house, which sold for $450,000.

"The house would only appraise for $450,000 because that was the price for comparable homes in the neighborhood. It probably wouldn't appraise for $455,000," said Banks, who is also president of the Home Builders Association of Charlotte.

Banks had no choice but to absorb the extra costs.

"Just in lumber alone, I have a 1% erosion in my margins," Banks said. "There's really no wiggle room now. All that went away in 2009, so every builder has learned how to tighten up and build a more efficient home.

Large publicly traded builders have many of the same problems. For example, Toll Bros. (TOL) CEO Douglas Yearley said on the company's first-quarter conference call with analysts that his company's costs were up $3,000 per house during the first quarter.

But Toll Bros. has been able to raise prices on new homes, he said, as the company sees "increasing pricing power due to the release of pent-up demand colliding with limited supply.

At Estates at Sunnyvale in California's Silicon Valley, Yearley said, Toll Bros. "sold 30 homes in four months at an average price of $1.5 million" with prices "up $91,000 over those four months.

Room For Price MarkupsAt Hovnanian Enterprises (HOV), direct margin — including home-specific costs such as land, materials and labor — rose to 23.9% in the first quarter from 23.5% in the fourth quarter.

"We have experienced cost pressures on both labor and material through the first quarter of fiscal 2013," Hovnanian Chief Financial Officer J. Larry Sorsby said on the company's quarterly conference call with analysts. "However, on a consolidated basis, we've been able to raise home prices to more than cover the cost of these increases.

A spokesperson at one large publicly traded builder, who asked not to be identified, said "you don't really have many choices" given higher costs. "You can either raise prices or live with lower margins.

Meritage Homes (MTH) has managed to lift prices in some markets.

"We've been able to raise our (home) prices, particularly in the West, and we're getting a much better handle on our costs," CEO Steve Hilton said on the company's first-quarter conference call last week. "(But) about half of our (home) price increases are giving way to (construction) cost increases.

Hilton added in comments emailed to IBD that average construction costs rose 8% to 10% over the last year. In some markets, costs rose as high as 15% to 16%.

"I expect it to be lower than that over the next four quarters than vs. the last four quarters," he said.

Blake Massengill, owner of Massengill Design Build, a privately held builder based in North Carolina's Research Triangle, says he has been forced to raise prices on certain homes. But it's a tough sell.

"We've been trying to keep prices as tight as possible, but there's no choice for me now but to raise prices on some houses," he said. "It's very tough to explain to a customer when they see a price that's $10,000 higher now than a year ago, but you have to let them know that your costs are higher, too.

Industry data suggest that prices for new homes are inching up nationwide. Last week the Commerce Department said the median price of a new home rose 3% in March from a year earlier, to $247,000.

That's not enough to cover higher costs for materials and labor.

"The cost of framing a house today vs. last May is up about 50%," Massengill said.

Until producers of materials add more capacity, increase supply and lower prices, that problem probably isn't going away. In the meantime, builders must figure out how to work around it.

"I think we're going to see builders slow down production of homes in recovering markets because we have to let prices catch up," Evans Coghill's Banks said.

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